Fears of an economic slowdown must not stop China tackling overcapacity
Hu Shuli says while shutting down 'zombie' companies may cause short-term pain, it is a necessary part of an industry upgrade for long-term gains
Overcapacity, along with high local government debt and the property bubble, have been named as the three biggest risks in the Chinese economy today. With the government struggling to maintain stable growth in the face of severe downward pressures, tackling the problem of overcapacity won't be easy. But it must be done.
Industries afflicted with excess capacity are inefficient. They lead to distortions in resource allocation, diverting investments from where they would be most useful.
Chinese leaders have made it a goal to cut overcapacity in the past two years, and have ordered local governments to do so, but have their orders been strictly followed? By and large, provincial and city governments that said they have completed the task have complied in name only.
Many of them are hedging, waiting for their competitors in the other regions to cut production first. By being the last to act, they are hoping they would be the first to benefit when the economy rebounds. With less competition, the few left standing would be free to win a bigger market share.
Thus, instead of winding up the inefficient companies, local governments are helping them to tide over the bad times. Through the use of project approvals, loan levels, subsidies and tax rebates, openly or on the sly, local officials have been doing their best to prop up the "zombie" companies, particularly if they happen to be government-owned.
Overcapacity is hurting the economy, as can be seen in the lacklustre annual data provincial governments released just before the Lunar New Year. The 2014 results were especially poor for Hebei and Shanxi, for example, where the steel and coal sectors suffer severe overcapacity. If little is done, we expect worse for 2015.
There is no time to lose: we must recognise the dangers of overcapacity and act to avert further losses.
For one, the problem of overcapacity - a legacy of China's old development model - is more dangerous today than ever before. In the past, overcapacity tended to be a cyclical problem; it disappears in an economic upswing when demand rises.
But a huge chunk of global demand has been lopped off by the financial crisis of seven years ago, never to return. China itself is on a path of no return in its determination to restructure and upgrade its economy. Shutting down or rationalising the industries that have fallen behind the times is inevitable.
Many studies have concluded that China has entered late industrialisation. Though urbanisation is ongoing, the country already has much of the basic infrastructure, such as roads and housing, we need. This suggests that the related construction and building industries are near, if not already at, their historic peak.
As the Chinese economy advances, many sectors will flourish while others will fall behind. For many industries now struggling, it's pure fantasy to expect a global recovery strong enough to absorb their excess capacity.
Beijing clearly understands the problem. Unlike its declarations in the past to rein in excess capacity using administrative measures, its recent documents have insisted on taking a market approach to solve the problem. In the State Council guidelines released at the end of 2013, government leaders said companies should be grouped under four categories: the first group should be helped to expand so their excess capacity may be absorbed, while the rest should be transformed, merged or disbanded.
In the past two years, China has been moving away from a single-minded pursuit of growth in gross domestic product. This is commendable. However, we should acknowledge the tremendous pressures on local governments: shutting down outdated industries will cause massive unemployment, and those affected tend to be older, low-skilled workers. In this light, the government must ensure the social security net is sturdy.
At the same time, given that many of these sunset industries are in the business of making cheap and low-end products, the government must also nurture the industries for higher-end products, where skilled labour is desperately needed. This kind of industry upgrade leads the way to the sustainable growth we seek.
In many ways, the problem of excess capacity is a creation of government interference. As China is still shaping its market-led system, it falls to the government to act for now. In the long run, however, such decisions should be made through a mechanism in which the market plays a leading role.
In the short term, trimming excess capacity may accelerate the economic slowdown.
But, in the long run, such a move will in fact help put China on a path of sustainable development, as long as it presses on with its reforms to upgrade its industries and develop new pathways of growth. Thus, there is no sense in allowing overcapacity in the name of sustainable development.
